Elemental Altus Royalties Corp.'s (CVE:ELE) Intrinsic Value Is Potentially 92% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Elemental Altus Royalties fair value estimate is CA$2.29

• Elemental Altus Royalties' CA$1.19 share price signals that it might be 48% undervalued

• The US$1.90 analyst price target for ELE is 17% less than our estimate of fair value

Does the April share price for Elemental Altus Royalties Corp. (CVE:ELE) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Elemental Altus Royalties

The Model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$11.9m	US$14.0m	US$16.3m	US$18.1m	US$19.5m	US$20.7m	US$21.7m	US$22.6m	US$23.4m	US$24.1m
Growth Rate Estimate Source	Analyst x2	Analyst x1	Analyst x1	Est @ 10.52%	Est @ 7.96%	Est @ 6.17%	Est @ 4.91%	Est @ 4.04%	Est @ 3.42%	Est @ 2.99%
Present Value ($, Millions) Discounted @ 7.7%	US$11.0	US$12.1	US$13.1	US$13.4	US$13.4	US$13.2	US$12.9	US$12.4	US$11.9	US$11.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$125m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$24m× (1 + 2.0%) ÷ (7.7%– 2.0%) = US$427m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$427m÷ ( 1 + 7.7%)¹⁰= US$203m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$328m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CA$1.2, the company appears quite good value at a 48% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Elemental Altus Royalties as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.7%, which is based on a levered beta of 1.249. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Elemental Altus Royalties

Strength

• Net debt to equity ratio below 40%.

Weakness

• Shareholders have been diluted in the past year.

Opportunity

• Trading below our estimate of fair value by more than 20%.

Threat

• Debt is not well covered by operating cash flow.

• Has less than 3 years of cash runway based on current free cash flow.

• Not expected to become profitable over the next 3 years.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Elemental Altus Royalties, we've put together three additional elements you should assess:

1. Risks: Case in point, we've spotted 2 warning signs for Elemental Altus Royalties you should be aware of, and 1 of them is significant.

2. Future Earnings: How does ELE's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.